Half of tech suppliers face 'financial distress'

Economic crisis and merger boom threat to end user organisations

Almost half of all IT and telecoms companies are at risk of “near term financial distress”, according to a major study by AlixPartners, a global business advisory firm.

This financial distress – the prospect of default or bankruptcy within two years - among suppliers will further drive the already high level of merger and acquisition activity, the firm said, noting “the ‘winner-take-all’ trend (is) likely to continue".

Consumer electronics firms were most vulnerable – with the study highlighting 87 percent at risk, but telecoms firms were not far behind, with almost three quarters at risk, primarily from the debt load taken on to fund rapid network expansion.

Rapid industry consolidation can create serious concerns to end user organisations that have to deal with the risk of core systems and applications no longer being fully developed or supported as vendors are taken over.

Reduced R&D spending is another concern, with the study noting that European tech firms have actually reduced their levels of investment (capex as a percentage of revenue) from 10.2% in 2006 to 9.4% in 2010. In the UK the decline is sharper, down from 13.2% in 2006 to 9.5% 2010.

Traditional hardware-focused companies will be most affected by the tough economy, according to AlixPartners. It highlighted the way some are trying to transform themselves to software organisations, such as HP through its proposed acquisition of Autonomy and its planned divestiture of its personal-computer business. Profit margins for software companies were high in 2010, averaging 33%, the report noted.

Michael Weyrich, managing director at AlixPartners said that while the technology sector had outperformed many other areas of the economy during the current recession, it faced serious challenges. These included rapidly evolving consumer demand, intense global competition, narrowing margins, high leverage and the need for substantial investments in capital expenditure in a tight capital market environment.

“The gap between winners and losers is widening, and as a result, we expect continued, industry-rattling moves and changes, particularly from the strongest players,” he said.

According to the study, top-quartile companies in the industry generated 4.5 times higher earnings before interest, taxes, depreciation and amortisation(EBITDA) margins than lower-quartile companies.

The top-performing companies also invested four times more in capex (capital expenditures) as a percentage of revenue, meaning that the gaps between winners and losers could accelerate.

“More than just about any other industry, much of high tech faces a vicious cycle of the constant need to invest capital to drive product innovation and differentiation, and to keep up with the pace of new technology,” said Eric Benedict, managing director at AlixPartners